In June 2016, leaders from the public and private sectors and development partners gathered in Abidjan to discuss the links between fragility, resilience and financial sector development in Africa. This event, a joint initiative created by the African Development Bank, the Making Finance Work for Africa Partnership (MFW4A), FSD Africa, FIRST Initiative and the Initiative for Risk Mitigation in Africa (IRMA), also provided an opportunity to explore prospects for partnerships, innovative policies and private sector-led solutions to accelerate financial sector development in fragile situations in Africa.

In this fifth instalment of a six-part series, Amadou Sy, Senior Fellow and Director of the African Growth Initiative, Brookings Institution, looks at how innovative instruments and partnerships can help mitigate the risks facing financial institutions in fragile situations in Africa.

Participants noted that the perception of the risk of doing business in Africa is higher than warranted by recent economic progress such as the relatively higher GDP growth in many countries. As a result tools to help mitigate risks can play a role in financial sector development.

Ms. Cécile Ambert of the African Development Bank (AfDB) presented the AfDB Credit Enhancement Facility (CEF), which was established in 2015 to increase private investment in countries perceived to be high risk, especially for long dated investment. The facility is part of the AfDB's strategy to increase its loans to non-sovereigns including in fragile countries. It uses a risk sharing model rather than risk mitigation because risk is not lowered but shared, which allows the AfDB to take more risk on its balance sheet. Initial seeding was used as cash collateral to take exposures that are off-balance sheet exposures for the Bank. That cash collateral served as the equity base that was leveraged three times. Risk-taking capacity stands currently at about $700m with 19 transactions ($300m) approved at the board. The facility does not provide payment insurance but default guarantee as it only pays when there is default. Risk and revenues are shared to ensure sustainability and the facility is now seeking diversity in terms of regions, sectors, size, and maturity.

A lesson from the establishment of the CEF is the need to manage the risk of maintaining an arm's length relationship so as to avoid having only bad assets allocated to the facility. Without an arm's length relationship, the sustainability of the facility would be at risk. Also, to achieve the objective of scaling up the CEF, it will be necessary to balance its exposures and not focus only on one sector, be it fragile countries or renewables only or women only investments. The challenge is to mitigate the propensity to layer objectives over objectives.

The CEF does not focus only on fragile countries. Its main objective is to provide capital relief with a view to stretch the balance sheet. The same project that consumes four times in a fragile capital consumes three times in a low-income country (LIC) in terms of risk premium. The vehicle is leveraged so had it focused only on fragile countries, it would have not have been able to leverage as much as it did. Also its projects are large scale e.g. power plants which requires scale. It also needs to achieve a risk rating and for that needs to establish a track record. Ultimately the objective of the facility is not to subsidize the AfDB's loans.

Mr. Henry Morris of the Africa Finance Corporation noted the prevalence of short-term finance instruments and the dearth of tools to mitigate the risks of medium term project finance. He stressed the need to consider the level of coverage for the different phases of a project. In particular, the construction phase is the riskiest part of the project cycle and instruments and enhancements are critically needed at the early phases of projects. He added that Africa is in need of infrastructure but bankability is a problem. As a result, it is crucial to think about the type of support needed at the developmental stages of projects. In short, the focus should be not just on transactions but also on development. Mr. Morris suggested that because risk sharing and participation can come in various forms, stronger partners should take a wider stake in the risk participation and not on a pro-rata basis.

There is a need to think beyond the typical infrastructure sectors and developmental projects need to be widened in their definition. For instance, exploration for crude and gas could be included in this category as gas-to-power projects are also important for infrastructure. Concession-type projects like in a public-private partnership (PPP) could be encouraged as was done for the Henri Konan Bedie Bridge in Côte d'Ivoire. Finally, Mr. Morris stressed that liquidity risk can be important in fragile countries such as in the Nigerian foreign exchange markets.

Mr. Cedric Mousset of the World Bank stressed that capacity is a big constraint in fragile countries and there are no easy solutions. Capacity building should be done when there are incentives for financial institutions to reform, such as incentives to leverage market opportunities and improve markets. The supervisory and regulatory framework is key as it allows for adequate competition, restructuring, and the adoption of international standards such as the Basel standards. Mr. Mousset flagged the Conflicted Affected States in Africa (CASA) initiative through which the IFC provides assistance to fragile African states to rebuild their financial sector and improve the business environment.

Mr. Franck Adjagba of the GARI Fund noted that the Africa Guarantee Fund-the largest guarantee fund in Africa-recently purchased the GARI fund. The AfDB and UNECA helped to establish the AGF in order to help micro, small, and medium enterprises access finance. AGF offers two types of products to banks and private equity firms: portfolio guarantees and individual guarantees (for instance for large infrastructure projects). AGF also helps banks raise long-term funds including through guarantees.

Ms. Consolate Rusagara of the FIRST Initiative also discussed the role of credit guarantee schemes in a context where governments intervene in sectors that are deemed as risky such as SME finance. How do authorities design public guarantees that are sustainable? How do they design them so as not to create the wrong incentives by destroying the credit culture? How can we help design public guarantees?

The principles for public credit guarantee schemes (CGS) sponsored by the First Initiative and the World Bank Group help governments answer such questions. The 16 principles cover four key areas: (i) the legal and regulatory framework (foundations for a CGS); (ii) corporate governance and risk management (building blocks for effectively designed and independently executed strategy aligned with CGS mandate and objectives); (iii) the operational framework (provide essential working parameters); and (iv) monitoring and evaluation (how CGS should report on their performance and evaluate the achievement of policy objectives).

A survey of key stakeholders has highlighted a number of important issues:

Most CGS were founded as public enterprises but it would be good to have CGS as public-private schemes.

Who supervises CGS? The board? The central bank? It is important to have a supervisory authority.

Mandate of CGS is not very clear: supporting SMEs? Agriculture? Typically there is mission creep and layers are added to layers. It is important to include a very clear mandate.

Claim management process needs to be very clear to avoid the death of the credit culture.

Performance evaluation: accountability by management is needed and performance should be measured.

In short, CGSs are important instruments for risk sharing but the role of government and its objectives need to be clear and funding should be sustainable. CGSs are only one tool to manage risks and should not be used by governments for subsidies. CGSs do not replace prudential regulation. Instead, credit risk management by banks and microfinance institutions should be adequate.

In 1963 I went to Nigeria to seek the indigenous roots of what I expected, alas, to become the leading industrial nation of Africa. In my interviews with workers about their saving behavior, I found that many saved in a saving club, called esusu in Yoruba. I learned that the esusu dates back to the 16th century when it was carried by Yoruba slaves to the Caribbean where it is still widespread.

This was my first encounter with informal finance: savings-led! Later in Liberia I came across similar indigenous cooperatives in all 17 ethnic groups, including savings and credit groups and working groups as well as similar community-based arrangements. In towns, rotating savings groups predominated; in villages where regular incomes were rare people formed credit funds (ASCAs), with small, mostly weekly equity contributions - without a gender bias. They survived the civil war and are now, half a century later, to be included in an IFAD project.

With the ASCAs in Liberia I felt at home: Urmitz is everywhere. Urmitz is my home village where, in 1889, some 15 villagers formed a self-help group. During the same year a credit cooperative law was enacted, the group joined the Raiffeisen movement, kept growing, and eventually, in 1934, came under the banking law: as a Raiffeisen bank.

This experience inspired me, from my new base in Princeton NJ, to submit a proposal to USAID to help build a grassroots financial system on indigenous foundations. Unfortunately, the proposal, in 1969, was a few years early; it was only in 1973 that USAID sponsored the Spring Review on Small Farmer Credit, a scathing report of targeted credit and credit-driven agricultural development banks (AgDBs).

From microcredit to the microfinance revolution

I then watched with astonishment the rise of the microcredit movement, entering into the void left by declining support to AgDBs. For the new credit NGOs suffered from similar flaws as the AgDBs: donor dependency, credit bias, lack of self-reliance and profitability, and the absence of appropriate regulation and supervision. And they added a gender bias.

Recognizing these deficiencies led to a paradigm change around 1990, the "microfinance revolution", in which two of the authors were involved (also in coining the new term, microfinance). This paradigm shift spurred the reform of existing, and the creation of savings-led new, MFIs, among them inclusive (micro) finance banks.

Two centuries of inclusive savings and cooperative banking: the German experience

This paradigm change has a long prehistory. Since the 17th century, Europe experienced tremendous increases in poverty, creating new displacements and upheavals: traditional safety nets broke down, mass poverty spread. In Germany, preceded by pawnshops, widows'- and orphans' funds, a new breed of local institutions began to evolve around 1800: savings funds (Sparkassen) placing the poor at the center: foremost as savers. The Sparkassen offered special incentives to the poor: free doorstep collection services and stimulus savings interest rates. Their numbers and funds increased rapidly, enabling them to extend their outreach and offer credit to "the industrious and enterprising", such as craftsmen. From early on, they thus were inclusive, with services to the poor, non-poor, and eventually SMEs and the city or district for community investments. Two centuries later, Sparkassen serve >40 million customers (50% of all residents of Germany), with €1.2 trillion in assets (2015).

A different history of microfinance started around 1850 with the development of self-help groups (SHGs) - savings and credit associations, owned and governed by their members. The first urban SHG was initiated by Schulze-Delitzsch in 1850, the first self-reliant rural SHG by Raiffeisen in 1864, soon organized in separate federations of respectively Volksbanken and Raiffeisenkassen (merged only in 1974). After 160 years of evolution, they now serve >30 million customers (including 18 million members), and €800 billion in assets (2015).

The savings and cooperative banks are two of three pillars of the German banking system, providing inclusive universal banking services to all segments of society, including MSMEs. Self-organized federations, central funds and auditing apexes, and appropriate regulation and supervision, have played crucial roles in their development. Government has been kept at bay. Ultimately, their strength lies in the mobilization of local savings for the local economy: the foundation of their crisis resilience.

What role for government in cooperative banking?

The case of India and Vietnam Since around 1900, the German credit cooperative model has spread around the world. In two of our case studies, India and Vietnam, we examine the role played by the state in that process. In 1904, the British Raj, inspired by Raiffeisen, introduced the Co-operative Credit Societies Act of India. By the mid-1920s, this had given rise to some 50,000 self-reliant credit cooperatives, backed by a network of cooperative banks. But ultimately, the Indian state governments played a destructive role: by taking over the operations of the cooperatives rather than providing a regulatory operating framework. By 2006, more than half of the 106,000 credit societies were insolvent, and more than one-quarter of the 1,112 cooperative banks reported losses. Reforms are struggling: of a sector which is too big to fail and too sick to heal.

Our contrasting story of Vietnam starts with the collapse, in the 1980s, of the socialist command economy and its cooperatives. In the early 1990s, the government launched a fresh credit cooperative initiative as part of a market economy, based on the Raiffeisen model. These People's Credit Funds (PCFs) have become one of the most impressive credit cooperative movements. PCFs are prudentially regulated and supervised by the central bank (SBV), which has not shied from enforcing compliance. They now profitably serve over four million clients (2014), having successfully weathered both the Asian financial crisis of 1997/98 and the global crisis of 2008. Most importantly, in contrast to India, the PCFs have not served as a tool of political favoritism.

Two inclusive commercial banks: Centenary and BRI

Finally, I am presenting two full-fledged inclusive commercial banks, one from Africa and one from Asia. Both are the product of transformations. Centenary Bank in Uganda started in 1985 as a "trust fund" of the Catholic Church.

Century-old Bank Rakyat Indonesia (BRI) dates back to a member-owned Volksbank (bank rakyat) in the 1890s, later transformed into a government-owned national bank. In 1969 it was commissioned to set up a network of village units, disbursing subsidized agricultural credit, in addition to BRI's main banking business. Their performance declined rapidly, and by 1982, BRI faced a choice: reform or close the units.

Technical assistance played a crucial role in transformation of both. Centenary was assisted by the German Savings Banks Foundation (SBFIC) together with IPC. They provided a highly effective cashflow-based lending methodology and MIS, combined with incentives for staff and borrowers. As microsavings continued to grow, exceeding the lending capacity of microcredit, Centenary added SME lending. It now profitably serves 1.3 million customers (2012), calling itself "Uganda's leading Microfinance Commercial Bank".

BRI was assisted by the Harvard Institute for International Development (HIID) to transform the village units into microbanking units as of 1984. Their success has rested on two products, both with commercial rates of interest: voluntary savings with positive real returns and unlimited withdrawals; and general credit, open to all and available for any purpose. These two products have made the microbanking units the largest national microfinance network in the developing world, resilient to the crises of 1997/98 and 2008. BRI, an MSME bank, currently serves 53 million customers (2015) with by far the largest outreach of any bank across the Indonesian archipelago.

The two banks, in vastly different countries, have much in common: individual lending, opportunities for graduating to SME loans, and genuine inclusiveness, excluding no one. They may be indicative of the future of inclusive finance, pointing the way to a new stage of institutional development - similar perhaps to the evolution of savings and cooperative banking in Germany.

Hans Dieter Seibel is a professor emeritus at Cologne University. He is specialized on microfinance and microbanking, linkages between informal and formal finance including digital linkages of SHGs with banks/MNOs, agricultural development bank reform, SME development, M&E, and sociocultural system research. In the 1980s, he designed the linkage banking program with GTZ, FAO and APRACA and was team leader of the first pilot project in Indonesia. In 1999-2001, he was Rural Finance Advisor at IFAD and author of its Rural Finance Policy. He also is a founding board member of the European Microfinance Platform (2006-2015).

In June 2016, leaders from the public and private sectors and development partners gathered in Abidjan to discuss the links between fragility, resilience and financial sector development in Africa. This event, a joint initiative created by the African Development Bank, the Making Finance Work for Africa Partnership (MFW4A), FSD Africa, FIRST Initiative and the Initiative for Risk Mitigation in Africa (IRMA), also provided an opportunity to explore prospects for partnerships, innovative policies and private sector-led solutions to accelerate financial sector development in fragile situations in Africa.

In this fourth instalment of a six-part series, Amadou Sy, Senior Fellow and Director of the African Growth Initiative, Brookings Institution, looks at the potential of digital finance to achieve broad financial sector development in countries facing fragile situations.

The number of individuals with mobile accounts in fragile countries is higher than the number of individuals with bank accounts. But what explains the rapid and broader adoption of digital finance in fragile countries?

Mr. Laurent Marie Kiba of Orange Senegal noted that two preconditions are needed for the rapid adoption of mobile finance. First, that the technology is available in fragile countries. Fourth generation wireless technology (4G) is available in Guinea Bissau. Second, mobile payment is no longer a project as populations have adopted it. Mobile operators recognize that mobile payment services are a branding tool and this helps strengthen the adoption of mobile financial products. Mr. Mathieu Soglonou of UNCDF stressed that mobile technology is a unique solution because it allows fast, large scale, secure transactions in a market environment and is a resilient technology.

Comparing mobile money with traditional brick-and-mortar banking, Ms. Aurélie Soulé of GSMA identified three benefits that mobile money offer in fragile countries. First, mobile money can be deployed rapidly because the associated capital expenditure is lower. Opening a branch can cost up to $400,000 and an ATM can cost $20,000 compared to no cost for a mobile agent. Second, proximity is high as the network of agents is in the community. And third, the security costs of moving money to branches, especially in countries with a sparse population, are not as relevant.

Going forward, solutions need to be developed to go beyond mobile money and offer a broad range of services akin to what a traditional branch would offer. Regulatory constraints such as those associated with KYC can be overcome with technology such as digital fingerprints. Crowdfunding solutions including with the diaspora and equity participation are options that should be considered.

Are the promises of digital finance exaggerated? Mr. Sasha Polverini of Gates Foundation noted that there is very little scale and less coverage in rural areas. He stressed that digital finance can be an effective solution for financial inclusion and development. Its success, however, depends on the nature of the crisis we are facing. Are we facing an economic crisis, a human crisis, a migrant crisis? What are the sources of fragility? The impact of digital financial services will depend on the answers to these questions. While many participants agreed with this observation, they noted that although the two can overlap, it was important to distinguish between financial sector development in fragile countries and financial inclusion in crisis situations.

Many participants asked about policies to reach the "last mile" of cashless transactions for the poorest. Panelists noted that we are still far from the true last mile although the acceptance of digital payments is progressing. It was noted that governments are big payers and having them adopt digital payment would be a big push. Mr. Kiba mentioned the experience of an oil company that managed to have 40 percent of purchases at its gas stations paid digitally. _________________________________________________________________

The global financial crisis has highlighted the vulnerability of financial systems and stressed the need for improving the management of financial vulnerability. The financial stability issue in low-income countries (LICs henceforth) has received less attention in recent years, insofar as they have been less impacted by the global financial crisis than emerging economies. However, a better understanding of financial fragility mechanisms in LICs is crucial. The experience of LICs shows that they could suffer sharp increases in non-performing loans and banking crises, and that the cost of banking crises is high, even if the banking sector is small.

In a recent paper, we investigate the determinants of financial fragility in advanced and developing countries, focusing on the interaction between credit booms and credit information sharing systems. A large number of studies have shown that excessive credit booms are one of the main drivers of financial crises. The development of credit information sharing (CIS) institutions may attenuate the negative effect of credit booms and/or limit the occurrence of such booms.

First, CIS can mitigate the negative effect of credit booms. A rapid growth of credits can weaken the quality of credit screening. During credit booms, credit officers cannot devote sufficient time to correctly screen new projects and bad projects have a higher probability of being financed. The presence of efficient CIS institutions could attenuate the negative effect of credit booms with screening. In addition, credit booms often fuel a rapid rise in asset prices (real estate and equity bubbles). Since assets may be used as collateral, the price rise will itself help an acceleration of credit growth ("financial accelerator") and reinforce the deterioration of screening. The presence of information sharing mechanisms may allow banks to diversify their portfolio. This diversification can limit the increase of asset prices induced by rapid credit growth, and therefore limit the detrimental impact of such episodes.

Second, CIS might affect the occurrence of credit booms, even if its effect is theoretically unknown. On the one hand, information sharing may curb credit growth by avoiding some customers borrowing from several banks. On the other hand, a reduction in the information asymmetries across banks may lead to an easing of lending standards and, in turn, an increase in the volume of lending (lending boom). Mechanisms through which CIS alleviates the detrimental and occurrence of credit booms can differ between developing countries and industrialized economies.

In order to identify the impact of information sharing and its transmission channel, we built a dataset combining a bank-level and country-level database. The sample included 159 countries with 79 developing countries and 80 emerging and developed countries over the period 2008-2014. To study whether developing countries differ from other countries, two groups of countries were distinguished: countries with a GNI per capita below US$ 4,125 in 2014 (n=79, called developing countries) and countries with a GNI per capita exceeding US$ 4,125 (n=80, called developed and emerging countries). Financial fragility was assessed by scrutinizing annual changes in the ratio of NPL to total loans. Episodes of financial fragility were identified every time this ratio jumped by at least 3%. This measure enabled capturing all episodes of financial distress and not only the extreme ones (banking crisis). The development of CIS was assessed by the depth index and the coverage of CIS. Both were extracted from Doing Business.

Estimations confirmed findings from other papers by highlighting the stabilizing impact of CIS. The paper also documented that this result held for both less developed countries (GNI per capita below US$ 4,125) and other countries (advanced and emerging). In a second step, the complex relationships between CIS, credit booms and financial fragility were analyzed. Econometric estimations pointed out several important results: (i) information sharing development had a direct effect on financial stability, even when the impact of credit booms was taken into account; (ii) the higher the scope of information collected, the lower the likelihood to observe a credit boom (but the coverage of CIS did not matter); this effect was smaller and less significant in developing countries; (iii) CIS mitigated the detrimental effect of credit boom but this result held only for advanced and emerging countries; and (iv) credit booms were strong predictors of financial vulnerability, especially in advanced and emerging countries.

These results have several policy implications. First, credit growth is a key variable for macro-prudential policies in low and middle income countries. Second, current efforts to develop CIS schemes should be strengthened, since the latter allow for credit expansion without excessive increase in the overall credit risk. Third, CIS has little impact on credit booms in developing countries, which justifies the extension of other tools - such as macro-prudential policies - to prevent excessive credit growth. Finally, extending the coverage of information sharing systems is not enough, since depth of information sharing is more efficient in avoiding credit booms.

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About the Authors

Florian Léonis currently a postdoctoral research fellow at CREA (University of Luxembourg). Samuel Guérineau is an Associate Professor at the Université d'Auvergne.

This work is part of a research project which received financial support from the DFID-ESRC Growth Research Programme (Grant No. ES/L012022/1). Other project's contributions focus on the implications of capital flows (FDI, aid, remittances) on long-term growth. All contributions are available and can be commented on the blog dedicated to the project.

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